Managing Your IRA

Imagine being able to compound your earnings every year with little or no tax consequences. Sound too good to be true? The generous gift from the government called an Individual Retirement Arrangement, or IRA for short, is a reality that few Americans take advantage of.

The following is an Individual Retirement Arrangement rundown, complete with tips on managing it.

managing your ira

To open an IRA, the qualifications are twofold: You must have earned an income of at least the amount that you plan to contribute, and you must have a social security number (or ITIN). As of 2008, you may deposit $5,000 per year of your pretaxed income into a Traditional IRA. Once in the account, you may invest as you see fit without paying capital gains or any income tax until you redeem this money. At the age of 59.5 you may redeem part or all of this money, which will be considered ordinary income and subject to the applicable tax rate at that time.

If you make less than $99,000 a year (or $156,000 if you are married), you are eligible to open a Roth IRA and contribute $5,000 per year. The Roth differs from a Traditional IRA in that you may only deposit post-taxed income. However, once you reach 59.5 you may cash out with zero tax consequences. Another major difference in the Roth is that you are not subject to required minimal distributions. This means that the government does not require you to withdraw anything from this account. In a Traditional IRA the required minimal distributions apply once you reach 70.5.

Use an investment calculator (you can find one at Yahoo! Finance), and the numbers speak for themselves. Let’s assume you begin contributing at age 18; you deposit $5,000 a year and your returns average 6.5% annually, a conservative estimate. At age 59.5, after contributing a total of $210,000, your IRA would be worth more than 1 million dollars. This return is worlds apart from what you would get putting that same money into a savings account or underneath your mattress.

Here’s how you can start investing in and managing your IRA account:

Opening an IRA account

Any investment management company, such as Vanguard, TD AMERITRADE or Scottrade, will be happy to assist you in opening an account. Direct your browser to their websites and they will take you through this simple process, step-by-step. You will need to have your employment information, bank account and social security number handy.

Before choosing a company, find out if they charge any yearly maintenance and/or trading commission fees. These costs can cut deep into your bottom line. For example, there is an annual $20 charge for each fund you own within Vanguard that has a balance of less than $10,000. Vanguard also charges a brokerage commission of $25 or $0.025 per share (the greater of the two) for each trade you make.

Depending on your age and retirement goals there are many different approaches to investing within your IRA. Three common objectives are cultivating growth, nurturing savings and yielding income.

Cultivating growth Younger investors who are nowhere near retirement have more incentive to take a little bit of risk in their investments. Day-trading or shorting stocks within this account are not recommended, but there are many ways to capitalize on high-growth sectors of the economy without gambling on individual positions that may swing wildly and ultimately bust under market pressure.

One way to cultivate growth is by investing in index funds that track the components of a particular sector of the market. Because these funds own many individual stocks they can provide you with broad exposure and, in effect, diversify your portfolio. Since they are passively invested, they do not charge excessive management fees. Three sectors that have historically provided growth are small cap stocks, energy and the emerging markets.

These also tend to fluctuate more than other sectors, but given that you cannot touch this money until you retire, there are fewer reasons to worry about short-term market variations.